Wednesday, December 10, 2008

Cutting hours, pay, prices, and rates

The RBI has slashed interest rates and the Government have cut excise duties by 4% across the board. The RBI is already grappling with the issue of banks not passing on the benefits of rate cuts to borrowers. How do we now get the banks and businesses to pass on the benefits to the borrowers and consumers? This is the big challenge now facing the Government.

Another related arguement has been contention that instead of laying off workers, companies should be encouraged to either cut working hours or salaries. It is said that this would spread the available work among more employees and also incentivize companies to keep hiring, thereby avoiding the trauma surrounding any mass lay-offs.

I have posted earlier, here, here, and here, that during uncertain economic times, businesses may not pass on the benefits of tax cuts to the consumers. The experience with tax cuts earlier this year with steel, automobiles, drugs, packaged food, and IT goods shows that retail prices may not come down.

Both these arguements - cutting prices and interest rates, and hours and wages - may run against the logic of "rational expectations" and "prisoners dilemma". The businesses, having factored in expectations of a protracted period of slowdown and with recent experience of the adverse effect of the higher input prices on their bottom-lines, may be reluctant to pass on the benefits to consumers. The companies who cut hours and/or wages instead of laying off workers, may be left facing the possibility of being gamed by their competitors who by refusing to toe the line can end up attracting all the good workers from the former.

The Government cannot arm-twist them to lower prices or hours or wages. Strategies that involve cutting prices, rates, wages and hours work only if there is a mechanism to ensure that everyone follows suit.

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The Government has announced a stimulus package that proposes an additional plan expenditure of about Rs 20,000 Cr ($4bn), cuts excise duty across the board by 4%, and incentives to exporters. The plan also authorised the India Infrastructure Finance Co Ltd (IIFCL) to raise Rs.10,000 Cr through tax-free bonds to refinance bank lending of longer maturity to eligible infrastructure projects, particularly in highways and port sectors. Import and export duties on a naphtha and iron ore have been eliminated.

Update 1
Some companies are going ahead with cuts in wages, allowances and working hours, to avoid lay-offs. The rolls of companies nipping at labor costs with measures less drastic than wholesale layoffs include Dell (extended unpaid holiday), Cisco (four-day year-end shutdown), Motorola (salary cuts), Nevada casinos (four-day workweek), Honda (voluntary unpaid vacation time) and The Seattle Times (plans to save $1 million with a week of unpaid furlough for 500 workers).

Update 2
Carmen Reinhart and Kenneth Rogoff, comparing post-war recessions in 22 countries, both developed and developing economies, finds that in developed countries, employers cut jobs instead of wages; in many developing countries, the situation appears to be the reverse. The greater (downward) wage flexibility in emerging markets may help cushion employment during periods of severe economic distress. The gaps in the social safety net in emerging market economies, when compared to industrial ones, presumably also make workers more anxious to avoid becoming unemployed.

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